The majority of collective investment vehicles holdings are in the form of mutual funds, exchange traded funds, exchange traded notes, trust vehicles, and other similar collective arrangements. These collective arrangements have the benefit of bundling a collection of assets and other financial contracts into a single investable instrument for an investor. Depending upon the related investment strategy and the anticipated target investor audience, one form of collective arrangement may typically be preferred (e.g. exchange traded fund or “ETF”, exchange traded note or “ETN”, mutual fund, or other).
Investment vehicles provide an important service to the individual and (non-financial) institutional investor. Such vehicles warehouse and manage a collection of assets, liabilities and other financial contracts. They allow investors to access instruments, returns and market directionality that are otherwise unobtainable in conventional investments.
The availability of these vehicles and opportunities is an important public policy matter. For example, they serve to reduce or eliminate the structural disadvantages which smaller investors may suffer. That is, smaller investors generally traffic in a less complete, less comprehensive, and less competitively priced marketplace.
Early examples of collective investment vehicles include money market funds, traditional mutual funds, and exchange traded funds with unleveraged returns over a portfolio of securities holdings.
A more recent extension of the collective investment vehicle has been vehicles which purport and attempt to provide investors with investment returns which are either: (a) inversely related to the movement in a related index (the “Inverse Return Vehicles”); or (b) positively related to index returns and amplified through a leveraging arrangement (the “Leveraged Return Vehicles”). Inverse Return Vehicles enjoy positive returns when the related index declines in value. For example, an Inverse Return Vehicle on U.S. equities would increase in value as the U.S. equity index it tracks declines.
On the other hand, Leveraged Return Vehicles enjoy amplified returns relating to the applicable index and may be directionally positive or negative. For example Leveraged Investment Vehicles on a foreign currency would enjoy increased value if the foreign currency appreciated. The level of increase or gain in the fund would be magnified by a multiple of the leverage.
Public Policy Considerations
The availability of sophisticated collective investment vehicles is an important public policy goal. An equally pressing public policy goal should be to engineer (or reengineer) collective investment vehicles to deliver accurate strategy and returns to the investing public. As of Jun. 30, 2012, the market capitalization of leveraged funds exceeded $13 billion. The market capitalization of inverse funds exceeded $17 billion. Also, as of Jun. 30, 2012, the aggregate amount of money market funds was approximately $2.5 trillion.
Structured funds are subject to delivering returns which can and have deviated dramatically from their investment objective. The market response to the deficiency in performance in leveraged and inverse funds has been to tweak the disclosure to limit the applicability of the fund's headline strategy to a single trading day. Structured funds are subject to considerable tracking error from the linked index. In addition, the results can sometimes be the opposite of what the fund purports to deliver.
The U.S. Securities and Exchange Commission (SEC) addressed the matter in a release entitled “Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors”, August 2009; see (http://www.sec.gov/investor/pubs/leveragedetfs-alert.htm). In response to the SEC release and commentator criticism, the fund community largely responded by tweaking fund disclosure to absolve the funds from suitable performance for periods which extend beyond a single trading day. A typical example of structured fund disclosure is as follows:                “ . . . [the fund] seeks a return of −100% of the return of an index (target) for a single day (before fees and expenses). Due to the compounding of daily returns, returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period. Investors should monitor holdings consistent with their strategies, as frequently as daily . . . ”        
Source: ProShares Short S&P500 Fact Sheet as of Sep. 30, 2010.
One point which distinguishes the disclosed embodiments from the current state of the art is the elimination, in the disclosed embodiments, of adverse path dependency. Under adverse path dependency, if the periodic index movements change direction (i.e. the index return series is not monotonic), the beneficial interests in such investment vehicles will underperform versus their targeted return. Returns may also be opposite from that intended.
As highlighted in the above referenced SEC release, the current state of the art investment vehicle performance may diverge from its intended course when measured over more than a single trading day. The disclosed embodiments by contrast cause the units to essentially track the intended course in typical market conditions for extended periods of time. As a consequence, the system outlined in the disclosed embodiments introduces a beneficial long term aspect to the securities market, investing and risk management in contrast to the one day speculative nature of the current fund arrangements.